Many FHA borrowers took advantage of record-low interest rates during the COVI9-19 pandemic and refinanced their mortgage. However, as of November 2021, there were over 4 million FHA borrowers who could realize a substantial reduction in their monthly payments by refinancing but had not done so. The average borrower in this cohort would save $229 per month ($2,750 per year) by refinancing their mortgage.
Low-to-moderate income (LMI), Black, and Hispanic households had slower refinancing rates compared to higher income, White, and Asian households during the pandemic-induced refinancing wave. As a result, low-balance loans, which are typically associated with low-income and/or low-wealth borrowers, made up about 75% of the refinance-eligible population. Borrowers with low-balance loans start with a higher mortgage rate and subsequently refinance at significantly slower rates because the associated fixed costs pose a significant impediment. Furthermore, because lenders have limited capacity, they tend to focus their efforts on refinancing higher-balance loans, which have higher returns, often at the expense of the LMI households with lower-balance loans.
In response, FHA should consider improving the pricing and removing the frictions associated with the FHA Streamline Refinance program as a way to enable more borrowers, particularly LMI, Black, and Hispanic households, to refinance. By our estimates, allowing borrowers who streamline refinance to roll closing costs into the unpaid principal balance of the loan, as well as implementing the other recommended pricing and process improvements, would sufficiently increase the incentives for borrowers and lenders alike to induce an additional 865,000 streamline refinances. More households would benefit from lower monthly payments, which in turn would reduce the likelihood they default on their mortgage and lose their opportunity to build generational wealth through homeownership. Given the racial composition of FHA borrowers and that 75% of refinance-eligible borrowers hold low-balance loans, the program adjustments would disproportionately benefit the LMI, Black, and Hispanic households that have not yet been able to refinance their mortgage.
While the recommended pricing improvement would modestly reduce FHA revenues, the full complement of program adjustments, including the pricing change, would reduce future defaults and claims, offsetting most or all of the cost to the Mutual Mortgage Insurance Fund.